Lesson 4

Part 2: Second Module Block

Micro- & Macroeconomics - Global Perspectives
(EC41_MBM)

Day 1 of Part 2
Amjad Naveed
 Economics looks like!! Microeconomics
Familiar??

• Demand curve
Need to • Supply curve
build • Equilibrium
these price and
types of quantity
• Production and
graphs ?
cost of firms
? • And
Investment
• etc.
relax!!!!!
Motivations
• Motivation for taking this class is try to read the news
paper or listen news from TV
Financial
crisis or low EU crisis
News about job loss
growth
or unemployment

When somebody loses

shares in stock market
Financial crisis and
crash in stock
market Firm problem, demand
and supply

Inflation and
investment
I dont like decision by
this Jobs firm ??
COVID-19 : Impact on Business or individuals
 Part 2: Second Module Block
Focus (aims)
1. Day 1
Understanding the price
elasticity of demand and the
Law of Diminishing Marginal
Utility and how to apply these
concepts.
2. Fair command of the concepts
of competition, asymmetric
info, market efficiencies,
including the models of
competition and oligopoly.
3. Understanding the basics
of market failures caused
by externalities and the
possible policies to deal with them.
4. Developing an ability to
interpret economic issues in
different ways according to
the variety of economic schools
and traditions presented in the
module and recognize the
limitations of the various
economic theories.
 Outline
1. Basic concepts of economics, branches,
demand and supply model (Repeat)
2. Elasticity (v-important) –Ch 17 (new)
● Demand elasticity
● Price elasticity
● Income elasticity
● Cross-price elasticity
3. Law of diminishing marginal utility (Ch-
18) (Remaining topic from module 1)
How to proceed?
1. Lecture
2. Exercises/Group
work
3. Discussion
4. Q&A
 Basic concepts of economics, branches, demand
and supply model (Repeat)
Economics ‘What is Economics? Economics is the study of social
science that deals with the efficient use of limited resources to achieve
maximum satisfaction of economic wants
Branches
• Microeconomics (focus in this course)
▫ Deals with the behavior of individual economic units
 such as, consumers, workers and firms. Or it studies the specific
choices made by consumers and producers
• Macroeconomics
▫ Study of the large economy as a whole or in its basic subdivisions
(National Economic Growth, Government Spending, Inflation,
Unemployment, etc.) You already have done macro part with Prof
Colin
Law of Demand, Supply and Equilibrium
• Law of Demand: when prices increase, the quantity demanded
decreases (assuming other variables do not change); inverse/negative
relationship
▫ Other variables/non-price determinants of demand:
income, taste, etc.
• Law of Supply: when prices increase, the quantity supplied will
increase, and vice-versa (assuming other variables do not change);
direct/positive relationship
▫ Other variables/non-price determinants of supply: cost of
production, wages, technology, etc.

Equilibrium: point when quantity demanded equals the quantity

supplied; QD = QS
Equilibrium example
Equilibrium QD=QS
Price P*=60p, Quantity Q*= 350 tonnes
Elasticity (ch 17)

Key concepts (basic definition)

• Price elasticity of demand
▫ responsiveness of quantity demanded to a change
in the price.
• Price elasticity of supply
▫ responsiveness of quantity supplied to a change of
price.
More about Elasticity
How to measure elasticity?
• Elasticity = percent change in quantity divided by the percent
change in the variable that caused quantity to change (i.e., price)

Price elasticity of demand:

Explanation or Interpretation of Elasticity

• When , demand is elastic:

▫ A given percent change in price causes an even greater
percent change in the quantity demanded.
• When , demand is inelastic:
▫ A given percent change in price causes a smaller
percent change in the quantity demanded.
• , demand is unitary elastic:
▫ A given percent change in price causes the same
Classifying Elasticities by Magnitude
The Variety of Demand Curves
Perfectly inelastic demand or supply
• Perfectly inelastic demand or
supply
 When does it happen?
 Quantity demanded/supplied does not change
in response to a change in price
 Examples:
 Life-saving drugs (near-perfectly inelastic
demand)
 Diabetics demand for insulin
 The supply of tickets for a particular concert
or sporting event
 Housing in SF area (near-perfectly inelastic
supply)
 What would demand or supply curve look
like, if it is perfectly inelastic everywhere?
 Infinite slope:  vertical
Perfectly elastic demand or supply
Perfectly elastic demand or supply
 The price elasticity is infinite, which implies
the quantity demanded/supplied is infinitely
responsive to miniscule changes in price
 This will be the case for linear demand or
supply curves that have slopes of zero –
those are horizontal.
 If the price is just above a horizontal demand
curve, the quantity demanded will be zero.
 If price fell just a bit, to below the curve, the
quantity demanded would be infinite.
• Example: the goods which have perfect
substitute
• Small producers corn (near-perfectly elastic
demand)
YouTube Video
• https://
www.youtube.com/watch?v=HHcblIxiAAk
(6min)
Exercise 1 (Elasticity)
Group work
• Suppose following table shows price and quantity demand
• Calculate and interpret the price elasticity of demand when
price changes from 6 to 5?
Price Demand

6 160
5 200
Solution Exercise 1 (Elasticity)
Price QD
6 160
• SOLUTION
5 200
Avg P: Avg Q:
(5+6)/2=5.5 (200+160)/2
=180


Interpretation
• |1.22| > 1 Elastic demand
• 1% change in price will bring 1.22% change in Qd
• 100% increase in price will bring 122% change in Qd
Exercise 2 (Elasticity) price QD
P1=2 Q1=10
• PROBLEM P2=2.20 Q2=8

• If the price of an ice cream cone increases

from $2.00 to $2.20
• and the amount you buy falls from 10 to 8
cones.
• Calculate your elasticity of demand and
Exercise 2- solution (Elasticity)
price QD
• SOLUTION P1=2 Q1=10
P2=2.20 Q2=8


Interpretation
• |2.33| > 1 Elastic demand
• 1% change in price will bring 2.33% change in Qd
OR 100% increase in price will bring 233% change
Exercise 3- (Elasticity)

From the following information, calculate price

elasticity of demand and interpret the restuls
• Point A: Price $4 Quantity 120
• Point B: Price $6 Quantity 80
Exercise 3- solution (Elasticity)

• Midpoint (or average): Price $5 Quantity 100

• Price elasticity of demand: .

• 

Interpretation
• |1| Unit Elastic demand
• % change in price is equal to % change in Qd OR 100%
increase in price will bring 100% change in Qd
 Exercise 4:
Elasticity using derivative concepts

Demand equation is given as,

QD=2400-400P

• Calculate price elasticity of demand at

▫ P= 4, P=3, and P= 2 ??
Exercise 4: solution
Elasticity using derivative concepts
Example: QD=2400-400P QD P
• Calculate elasticity at P= 4, P=3, and P= 2 ?? 2400 0

• First we need to calculate QD at different prices 1600 2

1200 3
800 4

• Where is derivative of Qd with respect to P, i.e., -4000 6

• At P=4, Elasticity= (4/800)= -2= |2|>1 elastic

Exercise 4: solution
Elasticity using derivative concepts
Example: QD=2400-400P QD P
• Calculate elasticity at P= 4, P=3, and P= 2 ?? 2400 0

• First we need to calculate QD at different prices 1600 2

1200 3
800 4

• Where is derivative of Qd with respect to P, i.e., -400 0 6

• At P=3, Elasticity= (3/1200)= -1= |1| =1 Unit Elastic

Exercise 4: solution
Elasticity using derivative concepts
Example: QD=2400-400P
QD P
• Calculate elasticity at P= 4, P=3, and P= 2 ??
2400 0
• First we need to calculate QD at different prices
1600 2
1200 3
800 4
• Where is derivative of Qd with respect to P, i.e., -4000 6

• At P=2, Elasticity= (2/1600)= -0.5= |0.5|< 1 inelastic

Exercise 4: solution (Summarize)
QD P
Example: QD=2400-400P
2400 0
• Calculate elasticity at P= 4, P=3, and P= 2 ??
• First we need to calculate QD at different prices 1600 2
1200 3

• Where is derivative of Qd with respect to P, i.e., -400 800 4

0 6
• At P=4, Elasticity= (4/800)= -2= |2|>1 elastic
• At P=3, Elasticity= (3/1200)= -1= |1| =1 Unit Elastic
• At P=2, Elasticity= (2/1600)= -0.5= |0.5|< 1 inelastic

• As you move down a demand curve, demand becomes less elastic,

eventually perfectly inelastic at the horizontal axis
Example: Elasticity on linear demand curve

• Example: QD=2400-400P
QD P Slope: DQ/DP
2400 0 -
1600 2 -400
1200 3 -400
800 4 -400
0 6 -400

• As you move down a demand curve, demand becomes less

elastic, eventually perfectly inelastic at the horizontal axis
 Example: Elasticity on linear demand curve

• Price
elasticity of
demand for
a linear
demand
curve

Notice that all along the straight-line demand curve, the slope is
constant (400) but the elasticity changes! So remember that slope
and elasticity are not the same thing
• Exercises (1-3)
 Elasticity of Supply
Price Elasticity of Supply
• Similar to demand elasticity, Price elasticity of supply is a
measure of how much the quantity supplied of a good responds
to a change in the price of that good.
• Price elasticity of supply is the percentage change in
quantity supplied resulting from a percent change in price.
• Same formula to calculate price elasticity of supply
P ercen tag e ch an g e
in q u an tity su p p lied
P rice elasticity o f su p p ly =
P ercen tag e ch an g e in p rice

( ) Δ Q 𝑎𝑣𝑔𝑃
𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦=𝐸 𝑄 𝑠 , 𝑃 = .
Δ 𝑃 𝑎𝑣𝑔𝑄
 Elasticity of Supply
Price Elasticity of Supply
Relative inelastic

Relative elastic
 Factors Affecting Price Elasticity (of
demand)
1. The Fraction of Income Spent on the Good:
▫ The more people spend on a good, the more important it is in their budget. So if its
price goes up, they are more willing to search long and hard for substitutes.
2.How Narrowly Defined the Good Is:
▫ “Bread” is a more narrowly defined good than is “wheat product”; “white bread” is
more narrowly defined than “bread.” The narrower the definition, the more
substitutes the good is likely to have and thus the more elastic its demand will be.
For example, the demand for Fords is more elastic than the demand for
automobiles; the demand for automobiles is more elastic than the demand for
transportation.
3.How Easy It Is to Find Out About Substitutes:
▫ The easier consumers can find out about the price and availability of substitutes,
the more elastic demand will be. Advertising plays a crucial role in increasing the
availability of substitutes to consumers.
4.How Much Time Is Available to Adjust to Price Changes:
▫ The more time consumers have to find out about substitutes, the more elastic
demand becomes.
Factors Affecting Supply Elasticity
1. How Much Time Is Available to Adjust to Price:
▫ A basic rule of economic life is that the faster one wants something done, the more
costly it will be. So when the price of a good goes up, firms at first increase output
very little. Then firms adjust by hiring more factors and expanding their plants, and
new firms enter the industry. With more time to adjust, the supply response
becomes larger.
2. How Easy It Is to Store Goods:
▫ When the price of a good drops, firms have to choose between selling it now or
putting it into their inventory if they believe the drop in price is only temporary.
Therefore, the cheaper it is to store goods, the more elastic the supply will be for
temporary changes in the price. For example, when the demand for steel
temporarily falls, steel manufacturers often store their unsold steel rather than
reduce their price.
3. How Cheap It Is to Increase Output:
▫ To increase output is costly. Typically, if an industry tries to buy more inputs, the
price of inputs goes up. Similarly, some production processes are quite costly to set
up. The less input costs rise and the smaller set-up costs are, the more elastic the
supply curve will be.
Income Elasticity

• Income elasticity of Demand: how sensitive is quantity

demand when income changes
• Or

where I stands for income.

• Example
▫ If a 10% increase in income results in a 30% increase in quantity
demanded, the income elasticity of demand is = 30/10 = 3
 Income Elasticity and Types of good
• Normal good: A good is a normal good if its demand goes up when
income increases
▫ Income elasticity of that good is positive E(Qd,I) > 0.
• Superior good: A good is a superior good if it goes up in demand
when income increases and its share in income also goes up
▫ Income elasticity of that good is greater than 1, i.e., E(Qd,I) > 1. for example
luxury good
• Necessity (or necessary) good: A good is a necessity if it goes up in
demand when income increases but its share in income goes down
▫ Income elasticity is between 0 and 1, i.e., (0 < E(Qd,I) < 1. for example food
etc.
• Inferior good: A good is an inferior good if it goes down in demand
when income goes up
▫ The elasticity of that good is less than 0 (or in minus), i.e., E(Qd,I) < 0. for
example potato for some peoples.
 Income Elasticity:
types of goods via elasticity’s sign
• Inferior goods:
– Negative income elasticity for inferior goods:
• meaning consumers demand a lower quantity of the good when their income rises,
are called inferior goods. Or consumption decreases with income

• Normal goods:
– Positive Income elasticity
• Meaning consumers demand more when their income rises. Consumption
increases with income.

• Luxury goods:
– Income elasticity greater than one
• normal goods with income elasticity greater than 1 are sometimes called luxury
goods. Or consumption increases with income at a rate greater than one
 Income Elasticity and Types of good
• YouTube video
https://www.youtube.com/watch?v=dc7ZQwv-xLQ
(about 5 min)
Cross-Price Elasticity

• Cross-price elasticity or CROSS ELASTICITY:

– This measures the responsiveness of the demand for a good (type A) to the
price of another good (Type B). We will denote it as E (Qd,Pog) where Pog
stands for Price of the Other Good. It is equal to:

E (Qd,Pog)

– Where A and B are two different products which could be substitute,

complements or unrelated.
Cross-Price Elasticity

• Cross-price elasticity and types of goods

– Complements: if cross-price elasticity is negative then both
goods (X, Y) are complements <0
• CDs and CD player, Peanut butter and jelly, car and gasoline , shoes and
lasses , mobile phone and cellular service provider, Printer and
Cartridge

– Substitutes: if cross-price elasticity is positive then both

goods (X, Y) are substitutes >0
• Roses and carnations, Pepsi and coke
• Elasticity using ‘Derivative’ concepts
• e.g., dy/dx= derivative of y with respect to y
▫ Or change in y divided by change in x

▫ Elasticity formula:
▫ is derivative or slope
▫ P and Q are equilibrium price and quantity or given
price and quantity
▫ Example on next slide
The Income Elasticity: Example
• The estimated demand function for avocados is:
• Q = 104 – 40p + 20pt + 0.01Y
▫ where we measure quantity in millions of lbs per month,
avocado and tomato prices in dollars per lb, and average
monthly income in dollars.
▫ Question: what would be the income elasticity of demand for
avocados if Q = 50 and Y = 4,000?
▫ Answer:
Since dQ/dY = 0.01, then
Income elasticity of Demand: 0.01(4000/50)=0.8
Cross-Price Elasticity: Example
• Again, the estimated demand function for
avocados is:
Q = 104 – 40p + 20pt + 0.01Y
▫ If price of avocados p is 2.75, price of tomato is pt=
$0.80 and income, Y=4000
▫ Find own price elasticity, Income elasticity of demand
and Cross price elasticity of demand?

▫ …… 0.8, 0.32
Utility And Law Of Diminishing Marginal Utility (Ch
18)

The Concept of Utility

• Utility is a measure of how “satisfied” consumers are. A
measure of happiness or well-being. It is not a measure of consumer
income
• A utility function mathematically describes the
relationship between what consumers actually consume
and their level of well-being.
▫ Represent consumers preferences
▫ Can take a variety of mathematical forms
• Utility functions: it is often denoted as
U(X1, X2, X3, Xn).
Utility And Law Of Diminishing Marginal Utility (Ch
18)

• Marginal utility is the additional utility a consumer

receives from an additional unit of a good or service.
• The law of diminishing marginal utility
states that as people consume more of a good
within a given period,
▫ (1) their total utility goes up, but
▫ (2) each added unit of the good adds less to their
total utility than the previous unit did.
▫ That is, as more of a good is consumed, its
marginal utility declines.
▫ Note that as more is consumed, total utility is
going up.
 TU
Example X unit Total Marginal
Total and of food Utility Utility 30

Total Utility (utils)

Marginal consumed =TU MU=ΔTU
Utility 20

Food= slices
0 0
of a pizza 1 10 10 10

After eating
too many 2 18 8
slices total
utility 3 24 6 0 1 2 3 4 5 6 7

4 28 4
Units of food consumed
increases

Marginal Utility (utils)

10
but MU 8
declines , 5 30 2 6
meaning the 4
satisfaction 6 30 0 2
0
he gets by MU
eating pizza 7 28 -2 -2
1 2 3 4 5 6 7
decreases Units of food consumed
Extra exercise for practice
MCQ
Elasticity measures
• A) the slope of a demand curve.
• B) the inverse of the slope of a demand curve.
• C) the percentage change in one variable in
response to a one percent increase in another
variable.
• D) sensitivity of price to a change in quantity.
The income elasticity of demand is the
• A) absolute change in quantity demanded resulting
from a one unit increase in income.
• B) percent change in quantity demanded resulting
from the absolute increase in income.
• C) percent change in quantity demanded resulting
from a one percent increase in income.
• D) percent change in income resulting from a one
percent increase in quantity demanded.
• E) percent change in income resulting from a one
percent increase in price.
 A vertical demand curve is
• A) completely inelastic.
• B) infinitely elastic.
• C) highly (but not infinitely) elastic.
• D) highly (but not completely) inelastic.
Which of these measures the responsiveness of the
quantity of one good demanded to an increase in
the price of another good?
• A) price elasticity.
• B) income elasticity.
• C) cross-price elasticity.
• D) cross substitution elasticity.
 MCQ
Which of the following represents the price elasticity of demand?

A)

B) ( )+( )

C) ( )×( )

D) ( )-( )
Exercise 5
Assume The demand for books is:
Qd = 120 – P , Qs = 5P
• What is the equilibrium price and equilibrium
quantity of books?
• Find the price elasticity of demand at
equilibrium price
• Interpret (explain) the economic meaning of
elasticity you find above?
Exercise 5 solution
Assume The demand for books is:
Qd = 120 – P , Qs = 5P

Qd=Qs
120-P=5P  P=120/6= 20, Q= 100
Elasticity= dQ/dP * P/Q
dQ/dP= -1
P=20
Q=100
Elasticity= -1 * (20/100)= -1/5= -0.2= |0.2|< 1 inelastic.
1% change in price will bring 0.2% change in Qd
 Exercise 6

The
Elasticity of
Demand for
Movie
Tickets
Elasticity - solution

• The
Elasticit
y of
Demand
for
Movie
Tickets
Elasticity - solution

• The
Elasticit
y of
Demand
for
Movie
Tickets
 Elasticity - solution

• The
Elasticity
of
Demand
for Movie
Tickets
Exercise 7
For the following goods, define if the elasticity will be high or low
and why?

• Paracetamol
• Peper
• Tickets for a theater performance
• A small car
• Living space
Exercise 7 - solution
For the following goods, define if the elasticity will be high of low
and why
• Paracetamol : low because medicine is needed
• Paper : low, because the cost of paper is low thus a small part
of the income is used to buy it
• Tickets for a theater performance: high, because there are
many substitutes and the expenses in relation to income is
relative high
• A small car: high, because there are many substitutes and the
expenses in relation to income is relative high
• Living space: high, the expenses in relation to income is
relative high
Question???

Next
Production, cost and profit
 Thank you for today

Questions?

Plan for tomorrow (& day after tomorrow):

• Production
• Market structures
• Production, cost and profit
References
• Wessels. J, W., (2017), Economics (Barron's Business Review) 6 th ed. Barrons
Educational Series.
• Some Text from slides prepared by previous teacher Maria Mulder Karadimou
• Read the article: https://academic.oup.com/oxrep/article/36/Supplement_1/S94/5899019